Mo' Money, Mo' Problems

Mo' Money, Mo' Problems

Mini Teaser: A host of countries are making great economic strides, which means the burgeoning global middle class is demanding an ever-growing piece of the pie. That’s good news, but it’s also causing higher prices for just about everything you could want. Th

by Author(s): Daniel Altman

RISING PRICES in commodity markets have caused alarm, protests and even violence in places as diverse as Egypt and the Philippines. Even in wealthy nations, higher prices for fuels, foods and raw materials are squeezing consumers and businesses, at times painfully so. The cause of this problem is fairly obvious: higher demand from the world's emerging economies, coupled with the usual growth in mature markets. The effects-and the solutions-are more complex.

Inflation doesn't exist in a vacuum. It is the rise of one price in terms of something else, be that how much you earn, the time it takes to procure what you're buying or simply what other desirable things cost. If all prices and wages rose at the same time, you wouldn't feel much of a difference. But when the prices of a few key products rise without a corresponding increase in wages, you feel the strain on your budget.

In the past several years, prices for crops, metals, minerals and fossil fuels have been climbing steadily. A broad index maintained by the International Monetary Fund has jumped 75 percent since the turn of the millennium. Prices for several scarce materials, like platinum and oil, have more than tripled.

The most-basic explanation is that supply has not kept pace with demand. The higher demand has its roots in rich countries and the booms of the past couple of decades, as well as in the opening of new markets. At the same time as consumers in the West were piling up unprecedented wealth, governments in the East were expanding their willingness and their ability to export.

Demand for energy and raw materials first came from manufacturers in poor countries seeking to supply consumers and businesses in rich countries. Soon they were followed by service providers as well. And eventually, the people working in those factories and back-office operations became wealthier themselves. Then they, too, began to demand more commodities, and other products based on commodities, for their own use.

That process has accelerated recently, and supply has not yet adjusted. With many-more bidders for roughly the same supply of commodities, it was inevitable that prices would rise and some bidders would be left empty-handed.

Yet as any economist will tell you, there is no better inducement for a new producer than rising prices, as long as costs haven't risen quite as much. The current inflation is not an inescapable spiral that will end in ruin. Rather, it is the beginning of one cycle in a never-ending series of changes and adjustments.

THE CAUSE of this inflation is on display for anyone who cares to look. Since the early 1980s, China has created a new middle class of roughly 300 million people. India has added perhaps 100 million. In other words, the global economy has added as many middle-class consumers as there are in the entire European Union. Even if they don't yet have as much income as the Europeans, they have similar desires to consume.

Moreover, your income doesn't have to rise in order for you to demand more commodities. You simply have to consume more commodity-intensive goods, which are produced ever-more cheaply thanks to innovations in technology, organization and distribution-as well as low-cost labor. For the price of a flat-screen television a decade ago, today you can buy a flat-screen television, a DVD player, a video-game system and a surround-sound speaker set. Demand for commodities can rise even in countries where wages are largely stagnant, like the United States.

For some farm commodities, it's a double whammy: more demand for food from emerging economies, plus more demand for food-based fuel from wealthy countries. Senator Charles Grassley, the Republican from Iowa, has said that an ear of corn isn't dinner for an American family. Well, it is for many families in other countries.

For some fuels, it's a triple whammy. If you're manufacturing plastics, you need oil first for your raw materials, then for the electricity to run your plant, then for the gasoline to deliver your product.

All of this explains why prices for commodities are rising, but it doesn't quite explain why they have risen so quickly. Even with the intense demand for oil, for example, the jump from about $20 a barrel in early 2002 to $120 earlier this year has been stunning.

Part of the reason for the dramatic changes in commodity prices has to do with expectations. The price of a barrel of oil today is determined not just by people who want to use the oil today, but also by people who may be buying supplies for the future. They will want to balance the price of a barrel of oil today versus a barrel of oil a few weeks, months or years down the road. And the price of a barrel of oil a few years from now will, in turn, depend on expectations about supply and demand a few years after that.

Today's oil price therefore involves an infinite chain of expectations leading from today to eternity. If anything changes those expectations, even a little bit, the price of oil today can fluctuate shockingly. The same goes for other commodities, too.

In the short run, which economists often think of as one to three years, constraints on supply can exacerbate those fluctuations. Imagine, for example, that the majority of rice was traded using long-term contracts, and there was very little loose supply on the market at any given moment. If demand rose sharply within a few months, bidding for that loose rice would be extreme. The daily price would skyrocket, even though most rice would still be sold, by prior agreement, at lower rates.

The emerging economies that are continually demanding more commodities have created a recurring version of this situation. They're constantly pushing on the margin of supply, so prices have risen steeply.

This inflation in commodity prices also leads to inflation in other industries. Almost all goods are made with commodities as their raw materials, and most services depend on commodities for tools and transport as well. Commodity inflation is already turning into general inflation, so ignoring food and energy prices by looking at a "core" index of inflation can be misleading in the short term and downright dangerous in the long term. This is true in developing countries with rising incomes, too, since they are starting to demand more commodity-intensive goods as well as the basic commodities themselves.

BECAUSE THE surge of economic growth in developing countries has pushed so many commodity prices upward at the same time, global inflation can feel like a monolithic trend. To be sure, the trend in demand is fairly uniform, but changing it is neither easy nor, in the case of demand driven by rising incomes, desirable. The trend in supply, on the other hand, is different for every commodity-and they have other unique qualities to boot. For that reason, most solutions to global inflation must be targeted and specific.

Crops are the easiest and fastest commodities to replenish. A rice paddy takes three years to mature, and a corn field can yield a crop in a single growing season. There is still much arable land in the world that is not being used for farming, though very little of it is in needy areas like sub-Saharan Africa. Fortunately, much can be done to expand the world's harvests from existing farms.

For starters, this may finally be the moment for a more-universal embrace of genetically modified crops. Though politicians, environmentalists and even scientists still have concerns about some strains of hybrid and transgenic plants, many strains have been shown to be safe. These strains, often hardier and higher yielding than their naturally occurring counterparts, offer a chance to provide much-more food per acre.

Farming techniques can improve, too. Training in the use of fertilizer, for example, has been one of the hallmarks of the Millennium Villages Project, which has helped Kenyan farmers to produce bumper crops. Those techniques are applied most inexpensively, of course, when they are applied on a massive scale. But before farms can be agglomerated, especially in many poor countries dominated by family plots, their governments must carefully define property rights and hand out titles. In Cambodia, for instance, a joint project between the World Bank and several nongovernmental organizations is creating twenty to thirty thousand new titles a month.

In addition, wealthy countries could take some of the tens of billions of dollars they use to subsidize their own farmers-sometimes to encourage them to keep their farms small-and give them to poor countries to help improve efficiency. Farming in wealthy countries is already very efficient; despite being one of the world's biggest crop producers, the United States devotes less than 0.7 percent of its workforce to farming, according to the Bureau of Labor Statistics. There are much-bigger gains to be had in poorer places.